Is the government on the hunt for a new approach to infrastructure?

What is it about the government and private financing for infrastructure?

For a long time the UK led the world in relation to clever project finance solutions: the private finance initiative (PFI) — where private firms are contracted to complete and manage public projects — has been used for over 600 different schemes. These include streetlighting, trams, hospitals, roads and housing. Then PFI fell from grace and for the past few years, with a couple of limited exceptions, there has been relatively little activity in procuring new UK infrastructure through private investment.

However, with the latest autumn statement came the announcement that a pipeline of projects to be delivered via the PF2 public private partnership scheme would be revealed in early 2017. The PF2 approach is intended to replace the PFI approach. Key differences adopted in the new approach include the government becoming the minority equity investor, and the length of the tender process being reduced.

Having seen only a handful of projects delivered via the PF2 scheme since its launch in 2012, to the infrastructure sector and industry leaders this was an announcement to be followed with keen interest. But with no such pipeline gaining even a mention in the Chancellor’s first (and last) spring statement, and the coinciding announcement that a joint taskforce will be established to explore options for piloting a Development Rights Auction Model (DRAM) in London, is the government on the hunt for a new funding model for infrastructure?

What is a DRAM?

Aimed at high-density areas, it seeks to capture additional land value by pooling land interests in the vicinity of transport infrastructure and auctioning the right to develop this land to a competitive field of bidders. The basic principles look like this:

Landowners will be incentivised to join an auction scheme whereby development rights on their land will be pooled with other landowners and auctioned as packages.

A reserve price is set which reflects the market value of the land package.

Any gain over the reserve price will be shared between the landowner and the authority on a (proposed) 60:40 split.

Necessary planning consents are obtained by the authority prior to the auction and bidders are therefore able to compete in a low-risk environment.

Successful bidders who develop land under the scheme will enjoy exemptions from section 106 and Community Infrastructure Levy development charges.

How did we get here?

In the 2016 spring statement, the government invited Transport for London (TfL) to develop proposals for funding transport projects in London using the Land Value Capture (LVC) model.

Widely regarded as an alternative method of funding development and infrastructure, LVC recognises that demand for infrastructure investment is growing, along with the price of financing the investment, which cannot be satisfied by increases in general taxation alone.

As it happens, landowners in catchment areas surrounding transport investment derive windfall gains from the infrastructure far in excess of the fares and other charges levied to fund the investment. The idea behind LVC is that a proportion of these windfall gains may be used to fund investments, generally those investments which in turn give rise to gains. Indeed TfL suggested that, “a sample of eight prospective TfL projects that cost around £36 billion (including Crossrail 2, the Bakerloo line extension and the DLR extension…) could produce land value uplifts of about £87 billion,” over a 30-year period.

Following joint consultation with the Greater London Authority, TfL recently made recommendations to improve the effectiveness of LVC going forward, one such recommendation being the introduction of a DRAM. Against the backdrop of TfL’s recommendations, it is recognised that greater powers over property taxes (Council Tax, business rates, Stamp Duty Land Tax and the like) will be instrumental to the implementation of a DRAM (and other recommendations) within London.

Curiously, it transpired that piloting a DRAM, and commitments in relation to business rates retention, were key features of the Memorandum of Understanding (MOU) agreed alongside the spring statement as to further devolution to London. Options for piloting a DRAM on a major infrastructure project in London will be explored by a think tank involving the government, the Greater London Authority, London councils, TfL and the Department for Transport. A timely addition for the capital as the uncertainty of Brexit awaits.

Is a DRAM the answer?

Adopting a DRAM sounds relatively ‘win-win’ for authorities: constraints on the public sector budget are considerably less than in the utopian scenario, the pooled land is transferred directly from landowners to the developer, and income streams derived from the uplift value may be unlocked in a shorter timeframe to accelerate the completion of infrastructure projects.

However… holdout landowners who are not sufficiently incentivised to join the auction scheme may arrive home to a compulsory purchase order in their letterbox (aided by passage of the Neighbourhood Planning Bill 2016) or suffer an escalating Community Infrastructure Levy; and while constraints on the public sector budget are considerably less, associated costs arising out of planning, obtaining consents and land acquisition will need to be considered in the mix.

In a budget which did not pledge support for Crossrail 2, it remains to be seen which “major infrastructure project in London” will be considered for the pilot — perhaps commitments outlined in the MOU relating to business rates retention and the Department for Transport’s involvement in the pilot think tank are clues?

Will DRAM present pathways to reinvigorating the infrastructure pipeline as PF2 was promised to do? Only time will tell. Or will it, at the very least, be a welcome alternative to those seeking a project-finance solution for infrastructure that is anything but PFI or its unloved step-child, PF2?